Increased Gas-Fired Generation to Drive Energy Prices Higher?

Jonathan Lee

From 2001 to 2011, natural gas as a source for electric generation accounted for about 20% of the total generation mix. During that same period, coal as a generation source accounted for around 48% of the total. As gas prices dropped and supplies became more abundant, gas-fired generation gradually increased, while coal-fired generation declined. Fast forward to 2012 when extremely mild winter temperatures led to an oversupply of natural gas and pushed prices to their lowest level in 10 years. Coal-to-gas switching accelerated and natural gas equaled coal at 33% of the total generation mix for the first time in history.

Throughout the balance of the 2012 year, increased power sector demand reduced the injection rate of natural gas into storage facilities. Market analysts grew concerned the trend could leave the nation with insufficient supplies heading into the peak winter heating demand period. From a low of $2.56/MMBtu on April 19, 2012, the rolling 12-month natural gas strip jumped 40.7% to $3.60 by the end of the year. Furthermore, several electric regions that are strongly correlated to natural gas, such as California and Texas, experienced similar upward pressure to wholesale electric prices.

With the cost of natural gas back down to levels not seen since 2012, the industry potentially finds itself in a similar situation this year. Lower gas prices make it more attractive for generators to burn the fuel to generate electricity. In fact, power burn for the first three months of the year was at a record high. The Energy Information Administration (EIA) estimated power sector demand averaged 22.7 bcf/day from January 1st through March 25th. In addition to the low cost of gas driving increased power sector demand, a fundamental shift in the generation mix is occurring due to stricter Environmental Protection Agency (EPA) regulations. In 2015, about 17,000 MW of coal-plant retirements will be replaced by about 10,000 MW of gas-fired plants. The EIA estimates 2015 annual power sector demand will average 24.1 bcf/day, which is just shy of 2012’s record annual high of 24.9 bcf/day.

With such similarities to 2012, does that mean prices will jump by 40% by the end of the year? Or will record gas production rates be enough to offset the anticipated growth in power sector demand and alleviate potential concerns over the amount of gas in storage? Time will tell. But if 2015 is anything like 2012, prices will eventually come under increased upward pressure. The question remains when and by how much. Even with the uncertainty ahead, the good news is end users currently have a window of time to take advantage of the low prices.